Connect America Fund Recon: What the FCC Taketh, the FCC Can – and Does – Giveth Back

FCC answers some questions on next phase of CAF, but raises new questions about the CAF Phase II and Mobility Fund Phase II Auctions

If we go just by the title of the FCC’s most recent action in the Connect America Fund (CAF) docket, the FCC accomplished quite a bit in one fell swoop. The lengthy (108 pages!) document is entitled “Report and Order, Declaratory Ruling, Order, Memorandum Opinion and Order, Seventh Order on Reconsideration, and Further Notice of Proposed Rulemaking.” Phew! (Let’s just call it the CAF Recon Order for short.) That just about runs the gamut of possible FCC actions, so we should expect a lot for our money. And, to a large extent, we got it.

The CAF Recon Order is a follow-on to the FCC’s massive and comprehensive attempt in 2011 to radically reform the entire regime of universal service funds (“USF”) and intercarrier compensation that has ruled the telecom landscape for a generation. That effort, grandiosely but not inaccurately dubbed the “Transformation Order” by the FCC, took an axe to the carrier-to-carrier rates and USF that previously paid for the high costs of completing long distance calls to rural areas of the country. Many prices paid by long distance telephone companies and wireless carriers, along with some previously available USF, were reduced, consolidated or eliminated over a period of a few years, and provisions that might have incentivized some operators to over-invest in upgrading their networks were eliminated. The availability of USF was eliminated as unnecessary for situations where, without reliance on USF, comparable service had been deployed.

The “transformation”, while dramatic, has proven to be less than permanent in a number of respects.

In a series of orders since 2011, the FCC has gradually and significantly modified the effects of the Transformation Order. Effective dates have been delayed. The decision to eliminate some USF has been reversed, making USF available again in certain circumstances.. And in a number of ways, the Commission has reconsidered how best to achieve the bedrock principle of ensuring that rural citizens can get phone service at prices comparable to folks in urban areas. That, after all, is what the original plan was all about.

In May the U.S. Court of Appeals for the Tenth Circuit, after undertaking the Herculean task of reviewing mountains of appeals by scores of parties unhappy with one or more aspects of the Transformation Order, concluded (in a 297-page opinion) that the FCC had acted lawfully. Having labored so hard to produce the Transformation Order in the first place, and having then successfully fended off a wide range of challenges to it, the Commission might have been expected to stick with its court-approved approach. But, instead, the Commission has continued to fine-tune that approach.

In addition, the FCC acknowledges that it has learned some lessons from the experience of the Mobility Phase I auction and is now prepared to consider implementing some of the suggestions that were presented to it – and rejected – at an earlier phase of the proceeding. As Commissioner O’Rielly pointed out in a recent blog posting, we are talking adult money here. Some $438 million CAF dollars have been doled out to price cap carriers, $300 million to CMRS providers under the Mobility Fund Phase I auction, and $50 million for tribal lands. The Commission also laid out the framework for the Connect America Phase II and Mobility Phase II auctions. There is a lot to chew on here, so let’s get started.

On the plus side for carriers:

• In 2011, the commission determined any incumbent Eligible Telecommunications Carrier (ETC) whose local service rate (plus state regulated fees) fell below a Commission-determined “rate floor” would have its high-cost funds reduced by an amount based on the extent to which its rate fell below the rate floor. That was supposed to take effect in July, 2014. Now, however, the Commission has decided to cushion the impact of that provision by phasing it in over four years beginning in January, 2015.
• In 2011, the FCC decided to eliminate the Safety Net Additive (SNA). Originally intended to provide funds to incumbent carriers who invested in their infrastructure, the SNA’s effect had become diluted because “infrastructure investment” was calculated, for SNA purposes, as a function of the number of lines in service. As lines decreased, the calculated “infrastructure investment” increased arithmetically, even if the actual level of new investment was zero. Because the SNA appeared to be ineffective, the Commission tossed it in 2011. But now the Commission has decided to allow carriers who would have qualified for SNA funds based on actual increased investment to receive such funds for investments made in 2010 and 2011.
• Funds to recover the high cost of rural local loops (HCLS) are no longer limited by the benchmarking rule calculated by Quantum Regression Analysis – a concept that was much debated but understood only by ratemaking geeks.
• Hefty FCC filing fees for redefining the service area boundaries of incumbent LECs have been waived, mainly because the boundary redefinition process is routine and requires little staff effort, and the cost of the fees was seen as a deterrent to transferring lines at the sub-exchange level.
• Telcos are assured of getting no less than their frozen USF from Phase I if they accept model-based CAF. This level is being phased out over three years.
• Rate of return carriers need not accommodate requests to provide broadband service where the incremental cost of undertaking the necessary upgrades to a particular location would exceed the anticipated revenues from the upgraded line, including state and federal USF.
• The FCC proposes to help rate of return carriers whose HCLS has been adversely affected by the continuing reduction in loops. This would be accomplished by basing the recovery of loop costs on a percentage of the National Average Cost Per Loop rather than on particular carriers’ own working loops.

The Connect America Phase II Process

The Commission has now clarified how the Phase II reverse auction process will work. In CAF Phase I the FCC had basically given price cap carriers dibs on the lion’s share of CAF, provided they agreed to build out broadband to FCC standards throughout their territories in an entire state. Many carriers declined to accept this largesse since the amounts offered by the FCC were not, in their opinion, high enough to pay for service to high cost areas. In Phase II, the FCC now plans to allow competitive bidding whereby bidders can offer to do the build-outs in areas that price cap carriers opted not to commit to build out.

• Bidders can propose to serve extremely high cost areas as well as mere high cost areas if they feel that it is economical to do so. (The original plan segregated service to extremely high cost areas.)
• Funds under Phase II are to be provided for ten years rather than five, allowing companies to make long term investment decisions.
• Price cap carriers can engage in the bidding process even if they rejected the opportunity to serve these areas in Phase I.
• The Commission continues to require CAF recipients to be designated as ETCs, a designation that required formal review and approval by the states or the FCC. However, the FCC will now allow entities to bid in Phase II without being ETCs at the time of the auction, provided they get so designated once they have won the auction. This option, which had been suggested by some commenters for Mobility Fund Phase I, permits a carrier to avoid the expense and possible commitments associated with applying for ETC status until it is assured that it will actually be receiving Phase II funding by winning the auction. However, the carrier then is obligated to obtain ETC status right away, something which is in the hands of often slow-moving federal or state regulators. Failure by a winning bidder to obtain ETC status after it has won the auction will result in default under the auction rules and imposition of penalties. Of course, a potential bidder can apply in advance for ETC status conditioned on its winning the auction, but then it may have wasted the money and effort involved in that process without ever getting funding.
• Although the Commission had earlier permitted but frowned upon the possibility that fixed wireless carriers could offer the basic broadband services required to qualify for funding, the FCC is now seeking comment on whether mobile or satellite carriers could also provide Phase II service of comparable quality. And if so, would service provided by such carriers be deemed to be provision of service by a carrier that precludes payment of USF to another carrier to serve that same area?
• Download speed benchmarks for Phase II providers are proposed to be set at 10 Mbps – up from the current 4 Mbps. Upload speeds would be 1 or 2 Mbps. Speeds could possibly rise over the ten-year term of the funding grants.
• Funding could be accelerated if Phase II awardees complete their roll-outs earlier than the three year (85% completion) and five year (100% completion) levels now specified.
• The FCC is considering allowing Phase II recipients to construct and be paid for less than all of the locations for which funding was provided and to substitute different unserved locations in partial census blocks from those originally funded.
• The FCC is considering whether to exclude from eligibility for CAF areas where a carrier is already providing the requisite level of service, regardless of whether the carrier receives the USF that replaced intercarrier compensation.
• The FCC proposes to pressure states to act on ETC designation petitions quickly by taking the matter out of the state’s hands if a proceeding is not initiated within 60 days of a petition being filed. The FCC also asks whether it should sunset obligations of ETCs to provide service after their funding runs out, a genuine concern where service is by definition not commercially sustainable.
• The Commission proposes to incentivize Phase II recipients to file their reports on time and meet service benchmarks on time by reducing their funding proportionally to the lateness of their compliance.

The Connect America Auction

• The Phase II auction would set as an upward reserve price for each area the price the Commission would pay in model-based CAF for state-level elections.
• The total amount of funding would not exceed the amount of Phase II funds left over after the state-level election process is completed.
• Bids would be prioritized based on whether they propose (i) substantially better service than the benchmarks set for model-based CAF, (ii) service equal to that required for model-based CAF, or (iii) a lesser level of service.

Mobility Fund Phase II

Mobility Phase I provided $300 million in one-time support for rural build-outs. Phase II is to provide up to $500 million per year for on-going operations support. The FCC now realizes that Verizon and AT&T have brought broadband technology to about 99.5% of the American public.   Again, this should not have come as a surprise since the Commission was reminded that build-out rules applicable to various spectrum bands would incentivize carriers to undertake these build-outs without subsidies. The Commission now proposes to target its Mobility Fund Phase II at areas of the country which are not served with 4G LTE by AT&T or Verizon. Since that would entail a far lower subsidy figure, the Commission proposes to repurpose the savings to the Remote Areas Fund or to Connect America Phase II.
Rural Broadband Experiments

Having plowed through the more than 1,000 expressions of interest which it received for rural broadband experiments, the FCC is moving forward in the near future to entertain the filing of formal applications for experimental broadband operations. In a new order adopted a month after release of the CAF Recon Order, the FCC announced that up to $100 million will be made available for very high speed broadband (25 Mbps) at lower support levels than apply to CAF Phase II and for tests of high speed broadband (10 Mbps) in high cost and very high cost areas. The FCC hopes to learn lessons from the competitive bidding process to use in structuring the CAF Phase II auction. These experimental proposals might be used to relieve price cap carriers of their commitments to provide service to those areas. The FCC also is considering whether rural experiment money should be annualized over ten years to provide a basis for comparison with carriers whose funding is parceled out over ten year terms.
Remote Areas Fund

Without much discussion, the FCC is proposing to hold off – until 2016 – on the plan to fund $100 million worth of annual service to remote areas, apparently figuring that some remote areas might actually become served under either Phase II or Mobility Fund Phase II.
The CAF Recon Order has been published in two separate parts in the Federal Register. One contains the portions of the order relating to adopted rules, which will take effect as of August 8, 2014 (except for Section 54.310(e)(1), which has to be run past OMB before it can become effective). The other contains the “Notice of Proposed Rulemaking” portion. Comments on the proposed rules are due no later than August 8, 2014, with replies due September 8. Comments may be uploaded to the FCC’s online filing site here, referencing Proceeding Number 10-90.